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Krugman, Newton & Zombie Banks

[T]he American economy doesn’t need more artificial and ineffective measures. We should be creating wealth, not printing dollars.

That word “artificial” caught my eye, because it’s the same word liquidationists used to denounce any efforts to fight the Great Depression with monetary policy. Schumpeter declared that

Any revival which is merely due to artificial stimulus leaves part of the work of depressions undone

Hayek similarly decried any recovery led by the “creation of artificial demand”.

Milton Friedman – who thought he had liberated conservatism from this kind of nonsense –must be spinning in his grave.

The Romney/liquidationist view only makes sense if you believe that the problem with our economy lies on the supply side – that workers lack the incentive to work, or are stuck with the wrong skills, or something.

Perhaps Krugman ought to consider more seriously the reality that since both Japan and now America have gone down the path of continually bailing out a corrupt, dysfunctional and parasitic financial system that neither nation has truly recovered.

Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish. While some surely perished from misfortune, and some surely survived from luck, this basic antifragile mechanism ensured the survival of the fittest agriculturalists and the transmission of their methods, ideas and genes to further generations. In the financial sector today the Darwinian mechanism has been turned on its head; in both Japan and the West, financiers have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure with injections of liquidity. Markets have become hypnotised and junkified, trading the possibility of the next injection of central banking liquidity instead of market fundamentals.

So it should be no surprise that financial institutions have continued making exactly the same mistakes that created the crisis in 2008. That crisis was caused by excessive financial debt. Many Wall Street banks in 2008 had forty or fifty times as much leverage as they had equity. The problem with leverage is that while successful bets can very quickly lead to massive profits, bad bets can very quickly lead to insolvency, liquidity panics and default cascades.

Following 2008, many on Wall Street promised they had learned their lesson, and that the days of excessive leverage and risk-taking with borrowed money were over. But, in October 2011, another Wall Street bank was taken down by bad bets financed by excessive leverage: MF Global. Their leverage ratio? 40:1.

So why was the banking system bailed out in the first place? Defenders of the bailouts have correctly pointed out that not bailing out certain banks would have caused the entire system to collapse. This is because the global financial system is an interconnected web. If a particularly interconnected bank disappears from the system, and cannot repay its creditors, the creditors themselves become threatened with insolvency. Without state intervention, a single massive bankruptcy can quickly snowball into systemic destruction. The system itself is fundamentally unsound, fundamentally fragile, and prone to collapse.

Government life-support has given Wall Street failures the resources to continue their dangerous and risky business practices which caused the last crisis. Effectively, Wall Street and the international financial system has become a government-funded zombie — unable to sustain itself in times of crisis through its own means, dependent on suckling the taxpayer’s teat, alive but yet failing to invest in small business and entrepreneurs.

The new policy of unlimited quantitative easing is an experiment. If those theorists of insufficient aggregate demand are right, then the problem will soon be solved, and we will return to strong long-term organic growth, low unemployment and prosperity. I would be overjoyed at such a prospect, and would gladly admit that I was wrong in my claim that depressed aggregate demand has merely been a symptom and not a cause. On the other hand, if economies remain depressed, or quickly return to elevated unemployment and weak growth, or if the new policy has severe adverse side effects, it is a signal that those who proposed this experiment were wrong.

Certainty is something that economists in particular should be particularly guarded against, even as a public relations strategy. Isaac Newton famously noted in the aftermath of the South Sea bubble that “I can calculate the motion of heavenly bodies but not the madness of people.” In the sphere of human action, there are no clear and definitive mathematical principles as there are in astronomy or thermodynamics; there have always been oddities, exceptions and quirks. There has always been wildness, even if it is at times hidden.

So we shall see who is right. I lean toward the idea— as Schumpeter did — that the work of depressions and crises is clearing out unsustainable debt, unsustainable business models, unsustainable companies, unsustainable banks and — as much as anything else — unsustainable economic theories.

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71 thoughts on “Krugman, Newton & Zombie Banks”

John: I’m not very confident that I, or most non-economists, can apply your discussion to the possibilities ahead, especially the U.S. presidential (and congressional) elections. Krugman, Schumpeter, et al — even Bernanke — will not be calling the shots. Then there’s the EU, ECB, possible German voting, etc. What will happen when “we shall see who is right”?

Why? Stocks are poised to soar on stimulus. It’s hard for a sitting President to lose when stocks are soaring. Bernanke went all in on stimulus, and quite possibly because Romney said he would replace him. I think the only realistic way Romney can win right now is if a shooting war breaks out in the middle east.

I normally agree with most everything you write, and I certainly agree that the problems we’re facing of low demand are a symptom not the problem.

However, I think suggesting that Bernanke went all-in on stimulus for career preservation is unfair. I don’t think he has shown any partisanship with his monetary actions, and we should remember he is a Republican. I think it’s much more fair to assume he went all-in now because the economy needs in (in his mind) and that he think it’s the appropriate time for it. I think he may be guided by perhaps poor ideas, but I don’t think it’s fair to suggest selfish intentions.

Bernanke’s perspective: — Romney will fire him and replace him with who? Jim Grant? Ron Paul? If Bernanke and the FOMC board believe that the US needs monetary stimulus and not liquidation (they do believe this), then Bernanke and Yellen may see this as their last chance to deliver.

Right, but Bernanke’s term doesn’t end until 2014, so if he felt that was the case (do it now in case Mittens gets elected), then I don’t think it logically follows, since in the worst-case scenario he would have had 2 more years (more or less) to enact monetary stimulus. I still think he’s just doing what he thinks is best.

“Imp: I beg to differ — you seem to have given up on mankind, resigned to “Curse God and (watch people) die.”!

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It’s not a matter of giving-up, instead, it’s a matter of dealing with things as they are.
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“Buddy’s* (presumably honest) report on Australia is not “romanticized”, and he is not creating a FANTASY to “play well”! He is DESCRIBING a society that works. Your “(not) outfit” — “all…colors, shapes,sizes and what-not” — but “within the temples”, is indisputably correct. But human brains are not programmed simply by aggregating a group, but rather one at a time by parents and community. This is a very complex subject, but let me offer a couple of anecdotes.”

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DG, that’s like saying the life works really well in upper/upper middle class America, so what’s the problem? The problem is that 99% of everybody else is getting hosed.
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“Bill Gates built an enormous corporate empire and has dedicated most of his wealth (and Warren Buffett’s) to third world (mostly children’s) health and education. As anticipated, it appears that The Bill and Melinda Gates Foundation is performing** far better than U.N. and government bureaucracies.”

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Yes, just the other night I was considering sending both Warren and Bill and check as I just can not understand how either of them will be able to get by on a net worth of only US$25B.

Although this is a very complex subject, the answer is always the same. In the x thousands of years of human history, the haves ALWAYS use their power to their own advantage.

Do you see this basic tenet of human social behavior changing anytime soon?

Society will always have social mobility, because sometimes poor people are just smarter than rich people. I think society is pretty egalitarian, anyway in comparison to how it was a hundred years ago, and is becoming more so thanks to technological innovation and improvement.

Any idiot anywhere in the world can learn calculus now for free online:

John, I believe its important to keep in mind that institutions [as imperfect as they are] are run by people who become leaders because they understand how the game is played. The game has not changed nor will it ever.

Even under the best of conditions, systems are horribly corrupt. If you do not believe this to be the case, then perhaps you can site an example of an institution that is different.

The point here is not to seem negative, but instead, to be realistic about what we can expect from institutions. A good example of this might be the absurd hopium the political system when another politician is elected into office.

This fairy tale – that it is the fault of the individual, and not the institution, that, by necessity, corrupts all individuals – is what perpetuates the notion that everything will be OK if we can just [fill in the blank].

I will always maintain that the purpose of all serious group activity is to separate as much wealth from individuals as is possible.

I have experienced the issue of corruption in religious and not for profit organisations. I trust no organisation, nor its officers, despite what their Mission Statement states!

When one can give up all worldly possessions and positions of power and influence, then they are truly free, and of noble praise.

I can only assume that the Powers in Control are corrupt and selfish. I have my dignity. They have nothing of substance.

I hope the Fed and the ECB are right. Because if they are wrong. A lot of people are going to suffer from the financial fallout. If we have another 50% collapse, retirees have effectively seen their life savings and potential consumption vanish. They worked as slaves effectively. This is not hyperbole. This is fact. In Australia the working class had 9% taken out of their pay to put away for retirement. Instead of spending now they could spend later. They were encouraged by fraudulent advertising to put their savings into riskier investments.

As an Accountant, the problem stems from the ability of immoral people to create a “Public Benevolent Institution” i.e. a registered charity or religious organisation. There is no way to legislate against immoral people creating it (How do you test). Most of these institutions have tax advantages i.e. pay no tax, so compete with other businesses to provide “services” They also have tax advantages for the people that work there.

The biggest risk is the tendering of contracts. During my Consulting I have seen massive contracts signed off without any tendering process (Despite my protestations). How do we know kickbacks are not received from donor funds. i.e. a donor gives 13 million dollars. A building is built for 13 million (really only costs 10 million. The contractor gives a kickback to the board.

I only give money to individuals who take the money direct to the recipients of their charity project, and not big NGO’s. I am hoping the individual is honest and not “living it up” but that is the risk we take when giving charity. Charity used to be like this before Corporate NGO’s and Government welfare.

Krugman strikes again. The underconsumption theory was a staple of economic thought in 1930’s America, as well. Just like today, they thought underconsumption was the root problem rather than a symptom of the root problem. The more things change, the more they stay the same.

But as I’m sure you’d agree, where the stimulus is directed will determine whether it will underpin or inspire demand. If it is mearly funneled to the actors who brought us this mess, and allows them to continue to gamble in their ponzi scheme – which we all know is what will happen – we’ll just see starving Somali’s and a bubble on top of the bubble.

Yet does that really deliver the fatal blow to the idea of fostering demand? If the QE was for the people, and the crisis was used to clear out the insolvency, a marriage of both competing economic theologies, could that not have another outcome?

Because the issue on the supply side is monopoly, oligopoly, and the concentration of capital in very few hands. I have many ideas I’d like to take to market, my competitors are Multi Nationals with deep pockets, my debt to one day own an inflated asset, my house, prevent me from being able to find the money, pay the talent, dedicate the time, to generating supply.

My friend talked yesterday about a steel company he buys from, they have just borrowed in order to pay the expected dividend to their shareholders.

So where does the moral hazard lie? Only with the addict? None of it at the feet of the shareholder? Or the peddlers of debt?

And can you really proclaim this a defeat of Keynsianism? When really what we’re looking at is Feudalism, Private Central Planning overlords, vacuuming the last crumbs up for themselves.

AAMC: “OR DO WE FILL THE WORLD WITH FOOLS AND FEAR TO ENABLE OUR FOLLY?”

Some do. Advertisers persuade women that it is more important to work in order to have fancy clothes, makeup and cars — than to stay home and raise their children. “Feminist”, Lesbian, and some politicians enlist women in war against family and children. For votes, Democratic Party politicians incite minorities and underclasses to blame and hate “the rich” and other skin colors.

I studied Advertising at a school run by the big advertisers themselves. The mindset of these guys is hideous. It is all about sales for the client. It is blatant propaganda and manipulation of gullible minds. It should be outlawed to be honest. It has ruined the values of society.

A sub Saharan African women must use “whitening gel” to get that “look”

What soon becomes apparent is that the richest 1000 families on Earth share strong, common interest to promote the natural bond that exists not just between themselves and the poorest, but also between all humans on Earth, if we are to accept what John Locke said – that a (private) property exists in each person; the only difference being that with the 1000 those properties include property external to their immediate persons, whereas the poorest simply have only their own selves.

Inadequate aggregate demand is a problem and QE3 or QEX does nothing to address it, which is a problem here for sure, perhaps somewhat less so in Japan. The problem with Krugman et. al is that he is hoping to restart the debt driven economy on top of the greatest mountain of debt ever created (?) which really can not be done. The problem originated with globalization and outsourcing which should have caused a permanent recession a long time ago, a recession that was postponed by issuance of fraudulent debt in very large quantities. When that came to grief, states attempted to monetize this debt for the well connected, who got rich on paper through the issuance of fraudulent debt, and states bankrupted themselves thus tying their own hands. What lies at the core of the problem is a theory that 7 billion people currently on Earth can enjoy the same prosperity as the “developed” world by cutting and pasting the western civilization upon them. This can not be done for reasons of inadequate resources. It remains to be seen whether something that feels like prosperity can be extended to the entire (and still growing) population, but to achieve this end new technologies need to be invented and commercialized. Instead of promoting such a development, globalization opened up, nearly instantaneously, a vast pool of labor which would work for food from day one. This pool of labor can not be promoted to consumers by raising their wages, as there are not enough resources to consummate their higher wage. So markets, left to their own devices, are taking us towards something like global Brazil. A global society of vast inequalities, with the available western style prosperity spread around to “elites” whose primary contribution to society is inventing ways to deliver that cheap labor while containing a threat of social explosion. This social solution is somewhat similar to dark ages, the time when a small minority lived well by finding ways to force the majority to hand their meager surplus to them. Dark Ages accomplished this goal to a large extend through religion, supplemented by violence whenever religion failed. Today, religion is still used in the “third world”, while theories of social darwinism are being used in “developed” countries to convince former middle classes of consumer societies that their impoverishment is their own fault. There are some important differences however between dark ages and today. In the past, impoverished masses were an asset for kings and princes as they were necessary to produce sufficient surplus. Today, the objective is to deny access to resources, and thus impoverished masses seem more like a burden than a necessary means to an end. Even wars can increasingly be fought by machines. Thus, impoverished masses are not just impoverished, they are also idle. You can finish this thought by yourself, I prefer not to, makes me depressed. What to do? Not an easy answer. Abandon the fiction that is globalization, and search for social solutions which are more local and suited to local conditions. Preserve enough social cohesion to trigger technological innovation, rather than descent into Global Brazil. To do this, we need courage to experiment with new social theories, rather than argue over old ones that no longer apply. We need new industrial revolution, not new morality, not return to old ideas that will somehow miraculously fix everything (gold standard anyone?). Courage to admit where human society now stands, and courage to experiment with new solutions.

mf, fortunately, you don’t have to concern yourself about any of the above [articulated with great care]. These things [quite nicely] rectify themselves. The particulars are simply part of the over all deal.

Life is not this movie playing down the Regal Cinema, but instead, individual discrete moments, interconnected and wholly dependent on an infinite number of moments preceding. Do not concern yourself with such that the human mind is simply incapable of understanding.

I agree with your analysis. Well written and thought out. My logical conclusion is save myself and loved ones. Perhaps others listening may use my words of advice.

I try to change the world through Political pressure, but I am only one man. Idealistic revolution only occurred because the printing press and pamphlets were novel and excited the youth of yesteryear. Now we have information overload. People resort to entertainment. The movie “Idiocracy” makes a fine analysis of the situation we are now in.

I know the QE infinity is the end game, so I am making my own preparations. We have been lead by idiots with their zealotry.

If QE infinity works, I will study Bernanke religiously, and earn a living providing “Pay Pal Skype Tutoring” to Online University/College students. I am a humble man.

If the amount of bank deposits were constant and productivity increased/decreased [regardless of an increase /decrease in goods/services produced], then the variable would be the value of the currency [or commodity] itself. This is essentially the same thing as bank deposits [of fixed value] increasing/decreasing.

No system can be static. All systems are dynamic [by their very nature] and therefore are limited by their manifestation in the four dimensions.

If bank deposits are constant then the money supply (M) is constant. An increase productivity (Q) would be offset by a decrease in the price level (P). The free market economy characterized by a falling price level. Hayek:

“the fall of prices proportionate to the increase in productivity … is not only entirely harmless but is in fact the only means of avoiding misdirections of production” (Prices and Production).

Weather, political instability, and sun spot activity have nothing to do with cyclical fluctuations. A one time event, like a war, can cause a downturn. But this has nothing to do with recurring boom-bust cycles.

MV=PQ is only a static system if we ignore expectations. But all prices are influenced by expectations. Entrepreneurs must forecast future cash flows and discount those cash flows at the interest rate. Cash flow forecasts and the interest rate are influenced by dynamic expectations. We’re dealing with dynamics every time we speak of changing prices.

BH, you’ve been taken prisoner by mathematics and its never ending attempts to explain Reality through equations and other non-nonsensical human rumination.

All things affect all things. Even as simply-minded as we be, you can certainly agree that weather patterns appear to be cyclical. Since food is dependent on such, I would believe that weather would be an important factor, perhaps, the most important one [see, ice ages].

Seems hypocritical: your concepts of statics and dynamics come from physics and engineering. Like Mises and Hayek, I’m a critic of mathematical economics

If weather causes recurring boom-bust cycles, then why aren’t there four boom-bust cycles each year as the seasons change? It’s because any cyclical change in weather can be predicted. People adjust their behavoir to avoid a boom or bust when the seasons change. The same is true of all cyclical weather patterns, like El Niño.

Recurring boom-bust business cycles are impossible in a barter economy. Cyclical economic fluctuations only become possible when we introduce money. Hayek:

“in the exchange economy, production is governed by prices … it is only when the pricing process is itself disturbed that a misdirection of production can occur” (Monetary Theory of the Trade Cycle).

There is some correlation with sunspot cycle and food price inflation — and there was much more during the mediaeval period — but it’s gotten much, much looser in recent years thanks to globalisation and mechanised production, fertilisers, etc.

BH, the particular boom-bust cycle you refer to is credit/debt. There is a lot more to this than meets the eye.

When examining factors that have an effect [all], try not to limit yourself to that which you can know. In other words, you are suggesting that, “the four seasons should… .” This is a very narrow view of time. Time is not what we believe it to be. How do you know what the cycles are, how they inter-play, over-lap, cancel-out, etc.? How do you even know what the weather is?

As far of where I derive my notions of stasis/dynamism, I’ll suggest to you that all things knowable are dynamic, all things Real, unknowable [but not static].

You do touch on something quite prescient when you state:

“Recurring boom-bust business cycles are impossible in a barter economy. Cyclical economic fluctuations only become possible when we introduce money.”

Indeed, the abstraction of labor-value into its money-form causes a great deal of chaos. I would tend to agree that this sleight-of hand acts as a de-stablizing catalyst; and would go further to suggest that the magnitude of boom-bust cycles would indeed be attenuated by a barter economy, but only by an amount unknowable and created through infinite variability [as are all things].

I proposed this to our Treasurer in Australia and Steve Keen. In fact Steve Keen personally berated me for hijacking his posts (And removed them bar one) with the proposal as I posted it on multiple topics before he created his new “fee” site. It s as follows:

The Government issues a Debit Card to all Tax Paying Citizens. The economy is contracted and expanded by regulating the “Credit Top up” on the Debit Card. The Credit is actually the Taxpayers taxes being withheld or released to spur or retard aggregate demand. It is not debt is actually our money but withheld to achieve “National economic goals” A bit paternalistic but more effective than a bureaucrat wasting taxpayer funds on things we don’t need. Demand would come from actual people. Business will invest according to greatest utility.

It would also remove the nee for a welfare bureau. People would receive say $100 a week minimum to “survive” This would free up expensive real estate IT and bureaucrats from administering welfare. Even billionaires get $100, because the costs of administering a progressive system would be more than the $100 per billionaire, millionaire etc.

When ever aggregate demand drops due to an external depressing event, the Treasury department would “juice” the card.

But this solution would put a lot of government workers out of a job, and property owners who get fat rents from welfare departments would miss out.

The very next day politicians will be stumping for votes promising $200 a week. Since envy will not be removed, only the “right” people will get $200. We’d be right back where we are today in less than 4 years.

You need to reread my post. It is not funded by debt. only taxes so it would result in a deficit which would go against the principles. A country can always borrow from overseas to boost the economy, but then it goes into deficit. The idea is to manage boom bust scenarios by eliminaring feedback loops caused by mass societal psychological mood swings. When demand is low and wage demands low i.e. Deflationery risks high you would pull forward demand. When the opposite occurs you stymie demand led inflation and overinvestment. A budget would have the debit card balance i.e. Our taxes held in a separate account. Once spent, the government would go into defitic, and be held accountable for blowing the budget. Like a kid using the family credit card.

Hello,
Darwinism is a teleology. It doesn’t tell You who is fittest for survival. It tells You “in fine” that he who has survived was the fittest.
If the Japanese zombie economy survives for several decades, then we will call it the fittest.
You should’nt invoke Darwin to condemn people not playing by the rules. The collusion of big corporations, central banking, and government goes by a name which should be exposed and is its strongest condemnation.
Cheers,
YM

It was “common practice for Florentine banks to operate with as little as 5% of their deposits held in reserve…The Florentine tavola operated with 5% reserves, and the Datini bank apparently did likewise. In its heyday, the Lyons branch of the Medici bank was even more extreme: on deposits of approximately 108,000 écus, a reserve was kept of only approximately 2,000, or not even 2%!”

“By 1494, the Milan branch of the Medici bank also ceased to exist. The branches that did not die off on their own generally met their end with the collapse of the Medicis’ political power in Florence in 1494, when Savonarola and the Pope struck against them. The central Florentine banco was burned by a mob, the Lyons branch was taken over by a rival firm, and the Roman branch struck off on its own despite the branch being bankrupt in general (ironically, they would suffer still more debts when a certain Medici cardinal became pope and inquired after the 11,243 gold florins he had deposited with the branch back when it was with the Medici bank). Even at the time of its downfall, the Medici bank was the biggest bank in Europe, with at least seven branches and over fifty factors.[39]”

Rather than dealing with the deflationary and painful consequences of just letting the banks fail completely; wouldn’t a better option be to find a way to wind down the banks in an orderly manner. This could be done with a nationalization of the banks. Then you could split apart the banks and reprivatize them.

Another solution could be to convert debt to equity across the entire financial system. If a bank is levered 40 or 50 to 1; we could forcibly convert the debt of the banks to equity. We could do this across the board to the entire financial system. Wouldn’t this be a better alternative than just letting the financial system liquidate?

Nationalization of the banking sector has been done so many times. Norway, Sweden, and Finland experienced banking crises in the 1990s along with Japan. All three of the Norwegian countries nationalized their banks; Japan didn’t. If nationalization was done in the Norwegian countries, it could’ve definitely been done in the US. Nationalization does solve the problem of having zombie banks.

yes we need an orderly transition. Unless the Government backs the deposits, you will see a bank run across the board. The GM example shows how to do this, but will we see the same issues we see with the Volt. Would the products the banks push as mandated by the government cause losses?